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Variable Life Insurance

What is Variable Life Insurance?

Variable life insurance is permanent life insurance that gives policy owners the option to invest the policy’s cash value into investment options offered by the life insurance company. This can yield faster cash value growth, but it also means the policy owner takes on greater risk if their chosen investments underperform.

Investing the cash value of a variable life policy

When you buy permanent life insurance, including variable life insurance, you have to pay premiums to the insurance company on a regular basis in order to maintain your coverage. The money you pay gets split into two parts. The first goes toward covering the cost of the insurance itself (basically, the death benefit and the insurer’s administrative fees). The second portion goes into an account that’s called the policy’s cash value.

When you choose variable life insurance, that cash value gets invested into the sub-accounts of your choosing. You can’t choose just any investment option, though. Instead, the insurance company will present you with a prospectus of several (usually, 20 to 50) sub-account options. These sub-accounts function very similarly to mutual funds, meaning your money gets pooled with other peoples’ and invested into the predetermined options.

Sub-account options vary from insurer to insurer, but your choices might include:

  • Indexes like the Dow Jones Industrial Average or NASDAQ

  • A money market fund

  • Bonds

  • Specific stock portfolios

Once you’ve decided how to invest the policy’s cash value, that cash value grows or shrinks based on the performance of the investment(s) you chose.

That said, most insurance companies set a minimum and maximum rate of return on variable life cash value accounts. This can protect you from a rapidly depleting cash value if your chosen investment vehicle dramatically underperforms, but it can also limit the returns you see in a given year if your investments thrive.

Investment management fees

One thing to note: because the investment component of a variable life policy is regulated by the U.S. Securities and Exchange Commission (SEC), variable life policies come with management fees just like other investments. The fees associated with variable policies are almost always higher than the fees for other types of life insurance.

Generally, the fees get bigger the more actively your insurer will need to be involved. If, for example, you opt to have a portfolio manager choose your investment options from the prospectus, you’ll usually pay more than you would if you picked them yourself.

Using the cash value in a variable life policy

Some people choose variable life insurance as an investment vehicle because cash value growth is not taxed as income. Then, you have a variety of ways to use that cash value and any tax-deferred gains.

  • Loan collateral. Your cash value can serve as collateral for a low-interest loan from the life insurance company. But if any loan amount is outstanding when the insured dies, that unpaid sum will be subtracted from the policy’s death benefit.

  • Cash withdrawal. You can withdraw the cash value as just that: cash. But if you withdraw more than you’ve paid into the policy (i.e., the total you’ve paid in premiums up to that point), the withdrawal is subject to taxes. In most cases, the amount you withdraw will be subtracted from the death benefit paid out when the insured passes away.

  • Death benefit increases. Some insurance companies allow you to apply your cash value toward an increase in the policy’s death benefit.

  • Payment in the event of a policy surrender. If you decide you no longer need life insurance, you can surrender your policy. You give up your coverage and in exchange, the life insurance company gives you the policy’s cash value. Policy surrender usually comes with significant fees.

Variable life insurance death benefit options

Many variable life insurance policies structure the death benefit just like term or whole life insurance. That means the policy has a face value determined when coverage is established. That amount is fixed and the beneficiaries will receive it when the insured dies (barring deductions from things like cash value withdrawals or outstanding loan amounts). This is called a level death benefit.

But some variable policies offer the option for face value plus cash value death benefits. With these policies, which cost more, the beneficiaries get the predetermined face value plus any cash value associated with the policy at the time of the insured’s death.

If you like the investment options of variable life insurance but want the flexible premiums of universal coverage, you can get both through a variable universal life insurance policy.

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